What to Do With Your Tax Refund If You Already Have an Emergency Fund

If you got a tax refund this year, you’re probably still giddy about the extra money. Who doesn’t love an unexpected windfall? Maybe you gave the federal government a little too much out of each paycheck last year. But what matters now is that you’ve got a tax refund in hand, and you want to be wise about how to use it.

If you have yet to decide what to do with your tax refund, it might be time to set some priorities. This is going to be relatively painless, and hopefully it will help you gain some clarity on the money issues that keep you up at night.

If debt is dragging you down, this could be an opportunity to pay off a credit card or two, or some other high-interest debt that’s been plaguing you. If your refund is anywhere close to the average—which was about $3,000 last year—you could potentially take a serious bite out of any balances you’re carrying.

If you aren’t in debt, but you haven’t yet set up an emergency fund, that’s another way to go. Most financial professionals recommend building up a fund that could tide you over for three-to-six months if you lose your job or can’t work. That fund also can help out with unexpected costs like car repairs or doctor bills.

And what if you’ve set up your emergency fund and don’t have any debt to pay off? If that’s the case, you’ve got plenty of options for your tax refund. One such option? Putting it in a high-interest account where cash is available when you need it but deposits also continue to grow—with interest. The money in your interest-bearing account could even grow to a down payment on a home or a graduate degree.

Then, there’s that “future” thing. How’s yours looking?

If you’ve checked off needs one, two, and three above, and are still you wondering what to do with your income tax refund, you might want to consider putting it in an investment savings account.

Okay, it may not have the same appeal as a 4K TV or a smartphone upgrade. But investing your income tax refund in a traditional or Roth IRA could give your bottom line a boost that you’ll be thankful for in retirement. Here’s why:

Instead of Spending Your Money, Help it Grow

With your continued contributions, a moderate rate of return, reinvesting, and the magic of compound interest, you can invest that hypothetical $3,000 tax refund for your retirement.

And if you start investing in your 20s or 30s, time is on your side. First, because you could consider choosing to take a little more risk, with the potential to earn more, since you’ll have years—even decades—to recover your money if the market corrects.

But even if you opt for a safer or more moderate portfolio, your years in the market will be working for you. Financial professionals often say “time in the market” beats “timing the market” because you can build your portfolio year after year just by buying and holding solid investments and rebalancing when necessary.

Social Security Might Dwindle

Some trustees are projecting that by 2034, the trusts that help fund our old age and disability programs may be exhausted. After that, they warn, if no changes are made, Social Security will be able to pay only 79% in promised benefits.

One solution, policymakers say, is to increase the age for claiming full retirement benefits—possibly to age 70 . (The current age when those who were born in 1960 or later can claim their full Social Security benefits is 67.) No matter what happens, you might feel a whole lot more prepared if you have plenty of savings to get you through what could be 30 or more years of retirement.

If you’re contributing to a 401(k) at work and getting a match from your employer, that’s certainly a good start. But there are limits to how much you can put into that account each year—and limits on the investment options available through most employer-sponsored plans.

You May be Able to Access More Investment Choices With a Traditional IRA or Roth

Employer-sponsored plans sometimes have a set investment menu supplied by the brokerage firm that holds your IRA. If you can’t find what you want there, or you’re looking for added diversity—or maybe you just need more advice than you’re getting—you could benefit from also opening a traditional IRA or Roth account.

Of course, if your employer offers a matching contribution, you’ll probably want to make the most of it. From there, though, you could consider other investment vehicles, like a SoFi Invest account. With a SoFi Invest account, for example, you’ll have access to thousands of assets, you won’t pay any management fees to SoFi, and you can tap into the expertise of our in-house financial planners.

It’s important to note that there are limits on how much you can contribute to each account and how much you can deduct from your taxes. The 2019 contribution limit for a 401(k) is $19,000 and $6,000 for a Roth and/or traditional IRA.

If you have a 401(k) and invest your tax refund in a traditional IRA, you may or may not be able to deduct that chunk of savings from your taxes, depending on your income. Even so, with two accounts you’ll be able to save more, and the gains will grow tax-deferred.

Another plus: There are special circumstances—including purchasing your first home or going back to school—when you can tap your traditional or Roth IRA for at least some of the cost without an early withdrawal penalty .

Tax-Advantaged Growth in Roth IRAs

With a Roth IRA, you won’t get any upfront tax deduction, but you will get tax-advantaged growth and tax-free withdrawals at age 59½ (if you’ve had the account for five years).

There’s no waiting period when it comes to withdrawing amounts you contributed to a Roth. If you invested your income tax refund today, you could reclaim it tomorrow tax- and penalty-free. (That said, if you’re planning to pull out money to go back to school or buy a house, it’s important to keep good records. You’ll have to prove that the money was a contribution, not earnings.)

If you’re a well-paid professional, you may not be able to contribute as much or at all to a Roth, because there are specific income restrictions. As your income rises, your ability to contribute phases out. But if a Roth IRA isn’t an option because of your high income, you could instead consider a traditional IRA.

Working With SoFi Invest

Many young professionals—particularly millennials—are often reluctant to invest their money in the stock market. They’re understandably more worried about the bills they have now—student loans, car and rent payments—than what will happen decades from now in retirement.

But saving what you can, when you can be a pragmatic choice. By opening an investment account with SoFi Invest, your tax refund windfall can become an investment in your future goals.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOIN18142